This Digest was prepared for debate. It reflects
the legislation as introduced and does not canvass subsequent amendments.
This Digest does not have any official legal statu s. Other sources should be consulted to determine the subsequent official
status of the Bill.

Contents

Passage History

Financial Sector (Shareholdings)
Bill 1998

Date Introduced: 26 March
1998

House: House of Representatives

Portfolio: Treasury

Commencement: The Act
cited as the Financial Sector (Shareholdings) Act 1998
commences on the commencement of the Australian Prudential Regulation Authority Act
1998 . The latter Act commences on the day it is proclaimed, but
that must be within six months of Royal Assent.(1)

Purpose

This Bill is one of a package of Bills(2) to implement the Government’s
response to the recommendations of the Financial System Inquiry (the
FSI) in its report the FSI report.(3) The object of this Bill is to
regulate the ownership and acquisition of prudentially regulated
financial institutions in accordance with the recommendation in the
FSI Report, subject to the changes referred to in this Bills Digest.(4)
The financial institutions, referred to as financial sector companies (FSCs) in the Bill, will be:

(a) any authorised deposit taking institution as defined in the Banking Act 1959;

(b) any insurance company authorised under the Insurance Act 1973;

(c) a company registered under the Life Insurance Act 1995; and

(d) a holding company of a company covered by paragraphs
(a) or (b) or (c).

The Bill seeks to ensure that the financial health of a prudentially
regulated financial institution is not affected by the adverse fortunes
of any particular individual person and or their associates. This will
be achieved by placing restrictions on shareholdings in financial
sector companies.

As indicated in the simplified outline of the Bill,
in proposed section
8 , the following measures are included in the Bill to restrict shareholdings:

â¢ ‘Financial
sector companies are subject to a 15% shareholding limit. The Treasurer
may approve a higher percentage limit on national interest grounds;

â¢ Those limits relate to a person’s stake in a company;

â¢ A person’s stake is the aggregate of the person’s voting power and the
voting power of the person’s associates;

â¢ A
person whose stake in a financial sector company does not exceed 15%
may be declared by the Treasurer to have practical control of the company;

â¢ The person
covered by the declaration must take steps to ensure that the person
does not have:

a) a stake that exceeds 15%; or

b) practical control; and

â¢ The regulations
may require records to be kept, and information to be given, for
purposes relating to the restrictions on shareholdings.’

A key recommendation of the FSI was that the existing institutionally
based system of prudential regulation should be combined in a single
agency at the Commonwealth level to be called the Australian Prudential
Regula tion Commission (APRC). The Australian Prudential Regulation Authority Bill 1998 , which
was introduced at the same time as this Bill and which seeks to establish
the Australian Prudential Regulation Authority (APRA), implements this
recommendation.(5)

Background

The
Financial System Inquiry and the philosophy underpinning prudential
regulation

The Wallis Committee was set up to stocktake the results of financial
deregulation of the Australian financial system since the early 1980’s,
to establish a common regulatory framework for overlapping financial
products and to propose ways of dealing with further financial innovation.

The Final Report of the Financial System Inquiry (FSI),
chaired by Mr Stan Wallis (President of the Business Council of Australia),
was released in April 1997. A number of recommendations were made to
intensify competition and efficiency in the financial system, including
recommendations for substantially streamlined regulatory arrangements.

In response to the FSI Report, the Treasurer announced
that the Government intends to institute a wide-ranging set of financial
system reforms.

The FSI took the view that Government intervention in the form of
prudential regulation should only provide an added level of financial
safety beyond that p rovided by conduct and disclosure regulation.
Further, the intensity of prudential regulation should be proportional
to the degree of market failure which it addresses, but it should not
involve a government guarantee of any part of the financial system.(6)

Financial safety, whilst being fundamental to the
smooth operation of the economy has an inherent risk component. The
FSI observed that risk is an essential component of any financial system
and, in an efficient system, is priced to reward those who bear it.
Prudential regulation is preventative in nature in that it is directed
at preventing breaches of financial promises through financial failure.
Ultimately, it is the responsibility of the management and the board
of a financial institution to deliver on the promises made, and it is
not appropriate for government to underwrite them. The framework and
approach to prudential regulation in the FSI Report is underpinned by
these philosophical considerations.(7)

With respect to the payments system, the Govern ment accepted
the Committees’ recommendations. Of special relevance to banking law,
the Committee recommended the formation of a Payments System Board under
the control of the Reserve Bank of Australia (RBA) to regulate the payments
system; liberalisation of access to the clearing system; regulation
of stored value cards; and laws to allow for electronic commerce. The Payment Systems (Regulation)
Bill 1998 details the proposed new regulatory framework for the
payments system, which is being introduced consistent with the recommendations
of the FSI.

Amendments to the Reserve Bank Act 1959 , as provided for in the Financial Sector
Reform (Amendments and Transitional Provisions) Bill 1998, provide for
the creation of the Payments System Board (PSB) within the RBA to provide
for policy making in relation to the payments system and to increase
the accountability of the RBA in relation to its role in the payments
system.

The need to spread ownership
of Deposit Taking Institutions (DTIs)

The FSI Report records that a regulatory regime which ensures
spread of ownership of a financial institution, which is a deposit taking
institution (DTIs), protects the institution from the adverse circumstances
of a major shareholder. It provides assurance that the financial system
is saved the contagion effect by association, should one institution
collapse, due to the circumstances of a major shareholder. As the FSI
Report notes: (8)

â¢ Spread of ownership
protects institutions against undue influence by a major shareholder
and creates a broad interest group in the shareholder base. The FSI
considered that the concept has sufficient weight to justify the continued
application of the spr ead of ownership objective as a general
principle for DTIs. The case is much weaker for insurance companies,
which are less susceptible to contagion effects.

â¢ The
Inquiry considered that the arrangements would be simplified by a single
threshold test. It favoured a single rule of 15 per cent which is the
level that applies under the regulation of foreign investment. Replacing
the various acts and rules with a single Acquisitions Act covering all
DTIs and insurance companies would streamline administration and remove
some of the inappropriate perceptions of the ‘specialness’ of financial
entities. Exemption for existing licence holders should be determined
by the APRC (even where the licence is held by an entity in the same
group).

â¢ Approval
for foreign ownership or ownership by non-financial entities above this
limit should be determined by the Treasurer (rather than the Governor-General),
giving consideration to the prudential regulator’s advice on prudential
matters, such as ‘fit and proper’ person tests and ability to meet
prudential standards on a continuing basis.

â¢ Giving
power of approval to the APRC would facilitate more efficient processing
of applications for ownership exemptions. All acquisitions would remain
subject to competition regulation, and takeovers of a public company
would remain subject to regulation under the Corporations Law. Other
requests for exemption would be relatively infrequent and should be
determined by the Treasurer (or APRC under delegation from the Treasurer),
applying a national interest test.

The need for a single threshold test will be appreciated when the
different limits set by the Banks (Shareholdings) Act 1972 (Cth) , Insurance
Acquisitions and Takeovers Act 1991 (Cth) and the Financial Institutions Code 1992 (FI Code) are considered.(9)
The different rules as summarised in the FSI Report, are set out below:

â¢ The Banks (Shareholdings)
Act 1972 places a general limit on shareholdings in banks of 10 per cent
of voting shares. The Treasurer may provide exemptions up to 15 per cent
and the Governor-General may provide an exemption up to any higher level
if this is considered to be in the national interest. To date, the higher
exemptions have mostly been applied to allow bank (or life company)
acquisitions of banks, or to allow foreign banks to establish wholly
owned subsidiaries in Australia.

â¢ The Insurance Acquisitions
and Takeovers Act 1991 provides that, where share acquisitions
or issues would result in a controlling interest of more than 15 per cent,
the Treasurer must be notified. The Treasurer then has 30 days to provide
a conditional or unconditional approval or to issue a restraining order.[
A footnote states that in practice, many acquisitions are authorised
by the Insurance and Superannuation Commission under a delegation from
the Treasurer].

â¢ The
FI Code imposes on building societies and potentially other institutions
under the FI Scheme, a general maximum shareholding limit of 10 per cent
of any class of shares but provides for exemptions in accordance with
standards issued by AFIC. The basic tenet of the standards is that exemptions
will be granted only for 100 per cent ownership by a conglomerate which
can satisfy a test as to spread of ownership of the ultimate holding
entity.(10)

The FSI Report Recommendati on 45 concluded that the principle
of spread of ownership should be retained and regulation rationalised
to impose a common 15 per cent limit. To quote the FSI Report again:

The general principle of a wide spread of ownership
of regulated financial entities (or holding companies where part of
a conglomerate) should be retained. Existing legislation and rules should
be streamlined through the introduction of a single Acquisitions Act
with a common 15 per cent shareholding limit. Exemptions may be granted
as follows.

â¢ The APRC should have
power to approve, subject to prudential requirements,
an exemption allowing a licence holder to acquire more than 15 per cent
of
alicensed institution; and

â¢ Any other person may
acquire more than 15 per cent of a licensed institution
only if the Treasurer approves the acquisition in the national interest.(11)

Main
Provisions

15
per cent shareholding limit

Division 2 of Part 2 of the Bill provides the mechanism for limiting
shareholdings in a financial sector company (FSC) to 15 per cent
or such higher percentage as may be approved by the Treasurer under
Division 3 of Part 2. Proposed section 10 gives the meaning of an ‘unacceptable shareholding situation’,
which arises where a person’s stake in a financial sector company
is more than 15% or such higher percentage approved under Division 3.
A note to proposed
section 10 states that a person’s stake includes the interests
of the person’s associates. Schedule 1 to the Bill is titled - Ownership definitions
- and includes the definition of terms relating to the ownership of
shares, interest in a share, associates, voting power, stake in a company
and direct control interests in a company.

‘Stake in a FSC’, as defined in proposed clause 10 of Schedule 1 to the Bill, is the aggregate
of the direct control interests of a person and that person’s associates
in the company.

The term associates is given a wide definition in proposed clause 4
of Schedule 1. It includes a relative, a partner, a company in which
that person is an officer, a trustee of a discretionary trust where
the person or an associate is capable of benefiting under the trust
either directly or indirectly through any interposed companies, partnerships
or trusts. The definition of associates also includes a company whose directors are accustomed
to act in accordance with the directions of the person, a company where
the person would apart from proposed paragraph 4(1)(j) have a stake of not less than 15%. Further, if the
person is a company - a person who holds, apart from proposed paragraph 4(1)(k), a stake in the company of not less than 15% is an associate.

The Banks (Shareholdings) Act 1972 (Cth) which places a limit of
10 percent on bank shareholdings will be repealed by proposed Schedule 3 of the Financial Sector Reform (Amendments and Transitional
Provisions) Bill 1998. Part 2 of the Insurance Acquisitions and Takeovers Act 1991 (Cth) which places
a limit of 15 per cent on shareholdings in insurance companies will
be repealed by measures in proposed Schedule 8 of the Financial Sector Reform (Amendments
and Transitional Provisions) Bill 1998.(12)

Approval by Treasurer to exceed
15% shareholding limit

The Bill gives the Treasurer power under Division 3 of Part 2 to approve
the acquisition of more than 15 per cent in a financial sector
company (FSC) subject to a national interest test. Proposed section 13 allows a person to apply to the Treasurer
for approval to hold a stake in a FSC of more than 15 per cent. Proposed subsection
14(1) provides that the Treasurer may grant the application if
the applicant satisfies the Treasurer that it is in the national interest
to approve the application. The approval may specify the period during
which the higher shareholding limit applies and, if no such period is
specified by the Treasurer under proposed subsection 15(1) , the approval applies indefinitely.
The Treasurer may grant such approval subject to conditions which are
specified in the notice of approval under proposed subsection 16(1 ) . However, proposed subsection 17(6 ) provides that the Treasurer may vary the percentage
specified in any approval if the Treasurer is satisfied that it is in
the national interest to do so.

Any approval given to a person to hold a stake exceeding 15% in a
FSC, extends to all the companies that are 100% subsi diaries
of that FSC.

The Treasurer may under proposed subsection 18(1 ) , by written notice, revoke an approval
if satisfied that it is in the national interest to do so, or if an
unacceptable shareholding situation exists or there has been a contravention
of a condition of approval. The holder of an approval may also request
that the Treasurer make a revocation. A revocation takes effect on a
date specified in the notice which must not be less than 90 days from
the date on which notice is given.

Copies of notices of approvals, extensions, variations and revocations
made by the Treasurer must be published in the Gazette and given to the FSC.

Practical control where 15%
shareholding limit not exceeded

Division 4 of Part 2 of the Bill provides that t he Treasurer
may declare that a person has practical control of a FSC, even though
that person does not have a stake in the FSC or has a stake less than
15%.

Proposed section 22 states that control includes control as
a result of, or by means of, trusts, agreements, arrangements, understandings
and practices, whether or not having legal or equitable force and whether
or not bases on legal and equitable rights.

Proposed subsection 23(1) provides that the Treasurer may make
a declaration that a person has ‘practical control’ of a FSC, if
the Treasurer is satisfied that:

â¢ the directors
of the FSC, or the company itself are subject to the directions, instructions
or wishes of a person either alone or with associates; and

â¢ that person
alone (or with associate s) has not more than a 15 per cent stake
in the FSC; and

â¢ it is in the national interest to make the declaration.

Proposed section 24 titled - Requirement to relinquish practical control or reduce stake -
provides that a person who is declared by the Treasurer to have practical
control must relinquish practical control by a variety of means including
by reducing their stake in the FSC. However, as will be seen from the
terms of proposed subsection 24(1) , there is an ambiguity in regard
to the availability of the option to reduce the person’s stake.

Proposed subsection 24(1) requires a person declared to have practical control
of a FSC to take steps to ensure that:

a) the directors
of the FSC no longer act in accordance with the directions, instructions
or wishes of the person either alone or together with associates
( proposed paragraph
24(1)(a) ; and

b) the
person is not in a position to exercise control ( proposed paragraph 24(1)(b) ; and

c) either:

â¢ the
person does not have any stake in the company ( proposed subparagraph 24(1)(c)(i) ; or

â¢ if
the person has a stake in the company - that stake is not more than
15% ( proposed
subparagraph 24(1)(c)(ii) ).

To comply with the these provisions a person
declared to have practical control must take steps that ensure that
practical control no longer exists in the manner described in proposed paragraphs 24(1)(a ) and (b) . As the person declared to have practical control may have
a stake in the FSC, which is not more than 15 per cent, the person could
comply with the requirement of proposed paragraph 24(1)(c) by:

â¢ either completely
divesting himself or herself of the entire stake in the FSC and fall
within the terms of proposed subparagraph 24(1)(c)(i) ; or

â¢ by
reducing the stake of that person still further from the percentage
held previously.

There is an ambiguity in the terms of proposed
subparagraph 24(1)(c)(ii) as it does not specifically state that
a further reduction in the stake may be required. In the absence of
this requirement proposed paragraph 24(1)(c) may have no particular effect,
because the person affected by the declaration must have already complied
with the requirements of proposed subparagraph 24(1)(c)(ii) or proposed subparagraph 24(1)(c)(i) at the time the Treasurer
made the declaration.

This same ambiguity exists in proposed subparagraph 25(1)(f)(ii) relating to the remedial
orders which the Federal Court is authorised to make on the application
of the Treasurer, where the Treasurer has made a declaration of practical
control.

Remedial Orders and Paragraph
51(xxxi) of the Constitution

The Bill provides for the Treasurer to
make application to the Federal Court for remedial orders if an unacceptable
shareholding situation exists under Division 2 ( proposed section 12 ), or if a declaration of practical control
has been made by the Treasurer under Division 4 ( proposed section 25 ). The Federal Court’s orders may include:

(a) an order directing the disposal of shares; or

(b) an order restraining the exercise of any rights attached to shares;
or

(c) an order pro hibiting
or deferring the payment of any sums due to a person in respect of shares
held by the person; or

(d) an order that any exercise of rights attached to shares be disregarded.

Proposed section 30 provides that the
Federal Court must not make an order, if the order would result in the
acquisition of property from a person on terms that would not be just,
or would be invalid because of paragraph 51(xxxi) of the Constitution.
This provision reflects recent authority of the High Court. A number
of principles have emerged on the interpretation of paragraph 51(xxxi),
following the decisions in five cases handed down by the High Court
in 1994: Mutual
Pools,(13) Peverill(14), Georgiadis,(15) Lawler(16) and Nintendo(17) . The Attorney-General's Legal Practice Briefing
No. 13 of 28 July 1994 examined the developments in the interpretation
of section 51(xxxi) in those cases against the pronouncements of the
High Court in the earlier cases and concluded rightly that ‘just terms’
involved full monetary compensation, as opposed to fair compensation
as had been perceived from the earlier cases. To quote the Practice
Note:

The cases produced little discussion on 'just terms'.
The Commonwealth had argued that 'just terms' did not necessarily involve
full monetary compensation but involved general notions of fairness,
and that a range of factors could be considered. Only Brennan J considered
these arguments. He rejected them: in his view section 51(xxxi) is a
guarantee that, when property is acquired in the circumstances to which
the provision applies, the burden will be borne by the taxpayers (or,
possibly, the person acquiring the property) and not by the individual
whose property is confiscated. This appears to be a more restrictive
view than had been put in statements in some earlier cases, which suggested
that there might be circumstances in which compensation at less than
full value of the property could be 'just'(18).

Prior to the 1994 cases, the High Court had held that ‘acquisition’
and ‘property’ in paragraph 51(xxxi) must be construed liberally
and not to be confined pedantically to the taking of title to some specif ic
estate or interest in land recognised at law or in equity but extends
to innominate and anomalous interests.(19)

‘Property’ as used in paragraph 51(xxxi) extends
to ‘every species of valuable right and interest and the right to
receive a payment of money including … choses in action’.(20)

In Newcrest Mining (WA) Ltd v Commonwealth the High Court in 1997
took the view that paragraph 51(xxxi) of the Constitution must be given
a meaning and operation that protects the basic rights of corporations
and individuals.(21)

Ordinarily, in a civilised society, where private property
rights are protected by law, the government, its agencies or those acting
under authority of law may not deprive a person of such rights without
a legal process which includes provision for just compensation. While
companies such as the appellants may not, as such, be entitled to the
benefit of every fundamental human right, s 51(xxxi) of the Australian
constitution must be understood as it commonly applies to individuals
entitled to the protection of basic rights. It must be given a meaning
and operation which fully reflects that application. In this way in
Australian law, it extends to protect the basic rights of corporations
as well as individuals.

A remedial order may therefore amount to an acquisition of
property having regard to the loss of rights of the person declared
to be involved in an unacceptable shareholding situation or in practical
control. It may in addition amount to an acquisition of property in
relation to the other shareholders and the FSC which may have been deprived
of the right to have a key person in control of the FSC. Thus there
may be circumstances where remedial orders may require the payment of
compensation by the Commonwealth to ensure compliance with the just
terms requirement in paragraph 51(xxxi) of the Constitution, which has
been reiterated in proposed section 30.

Depositors in a FSC may be expected to place their confidence in an
FSC based on their own assessment of the capabilities of persons holding
sub stantial interests in an FSC as well as the persons in control.
If a remedial order, intended to protect depositors generally, results
in a change of management or substantial shareholders it may be argued
that their rights to deal with a company of their choice has been interfered
with to their detriment. Whether such a right is ‘property’ is doubtful
based on the 1994 decision of the High Court in Nintendo .(22) This case concerned the sale by Centronics Systems
Pty Ltd (Centronics) of video games imported from the Nintendo Co Ltd
of Taiwan. It was claimed that the practical effect of the operation
of the Circuit
Layouts Act 1989 (Cth) constituted an infringement of intellectual
property rights of the Nintendo Co. Ltd. In the High Court, Centronics
argued that the impact of this legislation on their previous commercial
operation amounted to an ‘acquisition of property’ entitling them
to ‘just terms.’

Will decisions on control and
stakes in a FSC based on the National Interest Test attract Crown Liability
to Depositors?

It will be seen that the ability to restrict shareholdings of a person
and that person’s associates in a FSC to 15% is based on the pre mise
that it is not in the national interest to permit a higher holding generally.
Thus the Bill makes exceptions where the Treasurer grants an application
from a person to hold a higher stake than 15% where the Treasurer is
satisfied that it is in the national interest to approve the applicant.
An approval under proposed section 14 may be subject to such conditions as may
be specified in the notice of approval and proposed section 16 authorises the Treasurer to impose further
conditions or vary or revoke any condition. The conditions imposed by
the Treasurer may therefore be expected to be based on national interest
considerations. Again, proposed section 17 authorises the Treasurer to vary the percentage
holdings of a person which was specified in an approval under proposed section 14 on the Treasurer’s own initiative or
on the application of the person concerned, if it is in the national
interest to do so. Also, proposed section 23 authorises the Treasurer to declare a person to have
practical control of a FSC even where that person does not have a stake
in the FSC, if the Treasurer is satisfied that the directors act in
accordance with the directions, instructions and wishes of that person
and if the Treasurer considers that it is in the national interest to
make such declaration.

The question arises whether the Treasurer being vested
with such wide powers to take decisions on the stakeholdings and control
of a FSC in the national interest, on behalf of the Commonwealth, could
hold the Commonwealth responsible to depositors of an FSC in the event
of a failure of a FSC caused by the adverse financial circumstances
of stakeholders and persons in control of the FSC. This question would
arise whether the Treasurer approved a higher holding than 15 per cent
or not. In the latter case given the authority to reduce a stake of
a person the failure to act in time may carry the same exposure to liability
as approving an increase in the stake.

It is relevant to note that proposed subsection 5(1) states that the Act binds the Crown
in the right of the Commonwealth, of each of the States, of the Australian
Capital Territory, of the Northern Territory and of Norfolk Island. Proposed subsection
5(2) states that this Act does not make the Crown liable to be
prosecuted for an offence. As the Act binds the Crown and as the Act
clearly specifies that the Crown is not liable to be prosecuted for
an offence the question of civil liability for acts or omissions of
the Crown in the right of the Commonwealth is not affected by the measures
in the Bill. Section 56 of the Judiciary Act 1903 (Cth) authorises a person to bring a suit
against the Commonwealth in a claim, whether in contract or tort. Section
64 of the same Act provides that in any suit to which the Commonwealth
or a State is a party, the rights of parties shall as nearly as possible
be the same as in a suit between subject and subject. Thus the provisions
of the Judiciary
Act 1903 (Cth) would operate to enable any aggrieved depositor
to sue the Commonwealth, in the absence of measures to grant immunity
to the Commonwealth from actions in tort in the Bill. In Commonwealth v Mewett (23) the High Court held in 1997 that
the right to proceed against the Commonwealth in tort and contract stemmed
from the Judiciary
Act 1903 (Cth) which removed immunity from suit, but the liability itself
derived from the common law which was preserved by the Constitution.
It would therefore appear, that in view of this constitutional safeguard,
the right of aggrieved depositors of a FSC to sue the Commonwealth in
tort remains.

It is relevant to note that proposed section 70A to be inserted into the Banking Act 1959, by the Financial Sector Reform (Amendments
and Transitional Provisions) Bill 1998, in substitution of section 15
provides an indemnity to any person acting in good faith under the Banking Act 1959
in the following terms:

A person is not subject to any action, claim or demand
by, or any liability to, any person in respect of anything done or omitted
to be done in good faith and without negligence in connection with the
exercise of powers or performance of functions under this Act or in
compliance with obligations imposed by this Act(24).

Proposed section 58 of the Australian
Prudential Regulation Authority Bill 1998 also provides an indemnity
covering the APRA and its officers.

APRA, a Board member, an APRA staff member, or any agent of
a Board member or APRA staff member, is not subject to any liability
to any person in respect of anything done, or omitted to be done, in
good faith in the exercise or performance of powers, functions or duties
conferred or imposed on APRA, the Board or a Board member under this
Act or any other law of the Commonwealth.

It will be seen that the indemnity under proposed section 58 covers anything done or omitted to be done
under the Australian
Prudential Regulation Authority Act 1998 or any other law of
the Commonwealth. The Financial Sector (Shareholdings) Act 1998, when enacted will
authorise the Treasurer to delegate any or all of his powers to delegate
any or all of the Treasurer’s powers to the Chief Executive Officer
of APRA, or a member of the board of management of APRA or a APRA staff
member. However, as the Treasurer does not have an indemnity under measures
proposed in the Bill, officers of APRA acting under the delegated authority
of the Treasurer will not be able to plead an indemnity which is not
conferred on the Treasurer.

This Bills Digest considers the question of the continuing
implied guarantee in the paragraph titled Concluding Comments.

Interaction with Foreign Acquisitions and Takeovers Act 1975

Proposed section 45 provides that the Foreign Acquisitions
and Takeovers Act 1975 (FATA) and the measures in the Bill when
enacted will operate independently of each other. It is relevant to
note that FATA is an Act relating to the foreign acquisition of certain
land interests and to the foreign control of certain business enterprises
and mineral rights. Under Part 11 of FATA, which deals with control
of takeovers and other transactions, the Treasurer has wide powers in
the national interest to prevent the control of corporations by foreign
interests. A foreign interest is briefly defined as:

â¢ a natural person not ordinarily resident in Australia;
and

â¢ any corporation,
business or trust in which there is a substantial foreign interest,
ie, in which a single foreigner (and any assoc iates) has 15 per
cent or more of the ownership or in which several foreigners (and any
associates) have 40 per cent or more in aggregate of the ownership.

Thus a single person and associates seeking to acquire more than 15%
stake in a FSC will need to mak e application to the Treasurer
under proposed
section 13
of the Bill. Under paragraph 9(1)(a) of FATA, a person and any
associates of that person in a position to control 15 per cent or more
of the voting power or holding 15 per cent or more of the shares in
a FSC will be taken to hold a substantial interest in the FSC. Under
paragraph 9(2)(a) of FATA a person holding a substantial interest in
a corporation is taken to hold a controlling interest in the corporation
unless the Treasurer is satisfied that the person is not in a position
to determine the policy of the corporation. Thus a foreigner proposing
to acquire a 15 per cent stake in a FSC will come within the ambit of
FATA but not necessarily be prevented from holding 15% under the proposed
Bill. As proposed
subsection 45(2) states that a decision under either Act has effect
only for the purposes of the Act concerned, a person who has obtained
approval under FATA to have a 15 per cent holding in a FSC may yet be
declared to be in practical control under the measures in Division 4
of the Bill and required to reduce the stake in the FSC.

Under paragraph 9(1)(b) of FATA, two or more persons
are taken to hold an aggregate substantial interest in a company
if they, together with associate or associates of any of them, are in
a position to control 40 per cent or more of the voting power or together
hold interests of 40 per cent or more of the issued shares in a company.
Under paragraph 9(2)(b) of FATA, 2 or more persons holding a substantial
interest in a company shall be taken to hold a controlling interest
in a company unless the Treasurer is satisfied that that those persons
together with the associate or associates of any of them are not in
a position to determine the policy of the company. The Bill does
not have provisions corresponding to those in paragraphs 9(1)(b) and
9(2)(b). In consequence 2 or more foreign persons and their associates
can have stakes in a FSC, each stake being not more than 15 per cent,
and aggregating to less than 40 percent without reaching the thresholds
in the Bill as well as in FATA. Thus 3 foreign persons each holding
a 13% stake in a FSC will in aggregate hold a 39% stake in the FSC and
still not reach the 15% threshold limit in the Bill for individual persons
and the 40% threshold limit for aggregate holdings under FATA. Here
again, the measures in Division 4 of the Bill are wide enough for the
Treasurer to make declarations of practical in respect of each of the
3 foreign stakeholders in the FSC so as to prevent aggregate foreign
ownership which does not exceed 40 per cent.

Concluding Comments

Is there a continuation of
the implied guarantee to depositors?

The Regulation Impact Statement 2 (RIS 2) - Stability of the Financial
System and Depositor Protection(25) - in the Explanatory Memorandum
to the Financial
Sector Reform (Amendments and Transitional Provisions) Bill 1998
identifies two general problems with the current state of regulation
for depositor protection. These relate to the ambiguity of the protection
of depositors funds and the perception that their funds are guaranteed
leading them to seek the highest returns without regard to attendant
risks. This latter problem is referred to as the ‘moral hazard’
problem(26).

RIS 2 states that the regulatory objectives are to
achieve effective levels of depositor protection consistent with the
need to increase competition in the financial system, while minimising
moral hazard and to achieve clarity in the minds of depositors regarding the extent to
which their deposits are protected(27) .

To achieve these objectives RIS 2 states the following
five options were considered:

1. retention of the status quo;

2. deposit insurance;

3. retention
of the present protection arrangements with some consolidation and clarification;

4. remove explicit depositor protection provisions entirely; an d

5. industry self-regulation.

RIS 2 concludes that the third option builds
on the current approach, addressing the flaws contained therein and
is therefore the recommended option.(28)

The existing protection arrangements in the Banking Act 1959 are stated in RIS 2 as
follows.

3.92 The current legislative basis for depositor
protection is embodied in Division 2 of the Act. Section 12 of the Act
requires the RBA to exercise its powers for the protection of depositors
and section 16 gives priority to deposit liabilities above other liabilities. Section 14 provides triggers
for management intervention by the RBA and allows the RBA to assume
control of a bank. Although such action is in part discretionary (the
RBA is required to act in the interests of depositors), once taken,
the RBA under subsection 14(5) must remain in control and carry on the
business of the bank at least until such time as 'the deposits with
the bank have been repaid or the Reserve Bank is satisfied that suitable
provision has been made for their repayment'.

Under the measures in the Financial Sector Reform (Amendments and Transitional Provisions) Bill
1998, the only amendment to section 12 is to make that section
apply to all authorised deposit taking institutions (ADIs) instead of
to banks only, as at present. Sections 13,14, 15 and 16 are to be repealed
and substituted by proposed sections 13 to 16A . The comparative position is as follows.

â¢ If an ADI is
unable to meet its obligations, proposed subsection 13A(3) provides the assets of the ADI in
Australia are to be available to meet that ADI’s deposit liabilities
in Australia in priority to all other liabilities of the ADI. This corresponds
to the provisions of subsection 16(1) which presently gives priority
to deposit liabilities above other liabilities. Thus the contribution
presently made by subsection 16(1) to the perception that depositors
funds are in some way guaranteed by the Commonwealth will continue under proposed subsection
13A(3) .

â¢ The
provisions of subsection 14(5) which require the Reserve Bank of Australia
(RBA) to remain in control and carry on the business of a bank in difficulty,
until such time that the deposit liabilities have been paid or the bank
has been satisfied that suitable arrangements have been made for their
repayment, have been replaced by the provisions of proposed subsection 13C(1) . The proposed provisions are similar
except there is no express requirement that the APRA, instead of the
RBA, is to carry on the business of the ADI as the RBA is presently
required to do under subsection 14(5). It is arguable that it is not
necessary to require the APRA to carry on the business of a bank in
difficulty, as the need for the APRA to step in will only arise when
it is clear that the directors cannot carry on the business of the bank,
given the enhanced preventative measures available to the APRA
in the package of Bills.

It would be against the philosophy of prudential control adopted in
the FSI Report, for the Commonwealth to be held liable to depositors
for decisions taken in the national interest or to be held liable to
depositors on the basis of an implied guarantee. H owever, the
FSI did accept that it is difficult to completely shield the regulator
not only legally from this implied guarantee but that it may not be
in the best interests of ensuring continuing public confidence in the
financial system to remove the public perception of an implied guarantee.
To quote the FSI Report:

The Extent of Regulatory Assurances

The general philosophy underlying prudential regulation
is outlined in Chapter 5. Prudential regulation is preventative in nature
in that it is directed largely at preventing promissory breach through
financial failure. Recognising that no system of preventative regulation
is perfect in all circumstances, prudential regulation must also deal
with the resolution of failure when it does occur. A philosophical issue
constraining the design of a system of prudential regulation is appropriately
limiting the extent of any regulatory assurance that attaches to regulated
financial institutions and products regulated.

It is the Inquiry’s view that any regulatory assurance
should be tightly circumscribed. The reasons underlying this view are
detailed in Chapter 5. Ultimately, it is the responsibility of the management
and board of a financial institution to ensure that its businesses deliver
on the promises made, and it is not appropriate for government to underwrite
them. Prudential regulation adds an extra layer of oversight beyond
regulation of disclosure and conduct, but this should not constitute
a guarantee.

The Inquiry accepts that the extent of any regulatory
assurance is necessarily imprecise. Regulatory action will not always
follow the same predetermined path, since circumstances vary. In particular,
it is a reality of the regulatory system that financial distress will
be handled on a case-by-case basis where potential systemic risk is involved.

Further, systemic risk is related to perceptions. A
prudential regulator is required to strike a difficult balance between
increasing the likelihood that financial promises are kept and being
perceived as the underwriter of those promises. Even if regulatory responsibility
is clearly limited by law, the investing public may perceive the regulator
as implicitly guaranteeing the creditworthiness of regulated institutions.
Ironically, the regulator is perversely exposed in this respect to its
own performance ¾ the better its track record in preventing failure, the more
likely the public is to regard the regulator as guaranteeing the underlying
promises. Whatever the reality, perceptions can be a source of instability
if they are found to be incorrect.

This issue is important in the Australian context.
In some areas of prudential regulation, the extent of the regulatory
assurance is unclear, even in law. Beyond this lack of clarity, the
perceived extent of the regulatory assurance almost certainly exceeds
the legal extent in almost all areas of prudential regulation.

An objective of the framework and approach to prudential
regulation outlined below is to provide a structure that defines the
limits of any regulatory assurance as clearly as possible and offers
enough flexibility to adjust it, upwards or downwards, as the nature
of the financial system evolves.(29)

It would appear that the measures in the package of Bills have not
watered down the existing protection arrangements in the Banking Act 1959
as stated in paragraph 3.92 of RIS 2. These current arrangements have
lead to the perception that depositor funds are in some way guaranteed
giving rise to the moral hazard problem associated with such a perception.
It is therefore likely that the perception of a guarantee of depositor
funds will continue and so will the problem of moral hazard.

9. The Australian
Financial Institutions Commission (AFIC) is a statutory authority set
up under State and Territory laws in 1992. AFIC was set up by the Australian Financial
Institutions Code 1992(Queensland) and given effect in other
jurisdictions by an application of laws mechanism. The Australian Financial
Institutions Code (FI Code) is contained in the Part 7 of the Australian Financial Institutions Code 1992 .

Contact Officer

Bernard Pulle

30 April 1998

Bills Digest Service

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